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Cola Wars Continue: Coke vs. Pepsi in the 1990s

For decades, competition between Coke and Pepsi has been described as a “carefully waged competitive struggle.” The most intense battles in the cola wars were fought over the $48 billion industry in the United States, where the average American drank over 48 gallons per year. However, industry analysts contended that the U.S. soft drink industry had plateaued, and that total consumption was unlikely to increase significantly shortly. As a consequence, the cola wars were moving to international markets. “Coca-Cola used to be an American company with large international business. Now we are a large international company with sizable American business,” explained Coke’s CEO Roberto Goizueta.1 Coke, the world’s largest soft drink company with a 45% share of the worldwide soft drink market, earned 80% of its profits outside of the United States in 1993. Pepsi, with only 15% of its beverage operating profits coming from overseas, was using “guerrilla warfare” to attack Coke in selected international markets, noting that “as big as Coca-Cola is, you certainly don’t want a shootout at high noon,” said Wayne Calloway, CEO of PepsiCo.2 Roger Enrico, former CEO of Pepsi-Cola, described it this way:

The warfare must be perceived as a continuing battle without blood. Without Coke, Pepsi would have a tough time being an original and lively competitor. The more successful they are, the sharper we have to be. If the Coca-Cola company didn’t exist, we’d pray for someone to invent them. And on the other side of the fence, I’m sure the folks at Coke would say that nothing contributes as much to the present-day success of the Coca-Cola company than . . . Pepsi.3

As the cola wars continued into the 1990s, Coke and Pepsi had to struggle with age-old questions: could they maintain their phenomenal growth at home and abroad? What will happen to their margins with on-going warfare? And would the changing economics of their industry keep the average industry profits at historic levels?

Economics of the U.S. Industry

Americans consumed 23 gallons of soft drinks a year in 1970 compared to 48 gallons in 1993 (see Exhibit 1). This growth was fueled by the increasing availability and affordability of soft drinks in the marketplace, as well as the introduction and growth of diet soft drinks. There were many alternatives to soft drinks: coffee, beer, milk, tea, bottled water, juices, powdered drinks, wine, distilled spirits, and tap water. Americans drank more soft drinks than any other beverage, with the soft drink and bottled water categories being the only ones to increase each year. Since the early 1980s, however, real prices of soft drinks fell. Using 1978 as a base year, the Consumer Price Index (CPI) grew at an average rate of 5.9%, compared with soft drink price growth of 3.8%. Consumer demand appeared to be sensitive to price increases. The cola segment of the soft drink industry held the dominant (68%) share of the market in 1992, followed by lemon/lime with 12%, pepper flavor 7%, orange 3%, root beer 2%, and other 8%.

Concentrate Producers

Soft drinks consisted of a flavor base, a sweetener, and carbonated water. Three significant participants in the value chain produced and distributed soft drinks: 1) concentrate and syrup producers, 2) bottles, and 3) distributors. Packaging and sweetener firms were the major suppliers to the industry.

The concentrate producer (CP) blended the necessary raw material ingredients (excluding sugar or high fructose corn syrup), packaged it in plastic canisters, and shipped the blended parts to the bottler. The CP added artificial sweetener (aspartame) for making concentrate for diet soft drinks, while bottlers added sugar or high fructose corn syrup themselves.4 The process involved little capital investment in machinery, overhead or labor. A typical concentrate manufacturing plant cost approximately $5-$10 million to build in 1993, and one plant could serve the entire United States. A CP’s most significant costs were for advertising, promotion, market research, and bottler relations. Marketing programs were jointly implemented and financed by CPs and bottlers. The CPs usually took the lead in developing the programs, particularly in product planning, market research, and advertising. Bottlers assumed a more significant role in developing trade and consumer promotions and paid an agreed percentage of promotional and advertising costs. CPs employed extensive sales and marketing support staff to work with and help improve the performance of their franchised bottlers. They set standards for their bottlers and suggested operating procedures. CPs also negotiated directly with the bottlers’ significant suppliers—particularly sweetener and packaging suppliers—to encourage reliable supply, faster delivery, and lower prices. Coca-Cola and Pepsi-Cola were CPs and bottlers, while Dr. Pepper/Seven-Up, Cadbury Schweppes, and RC Cola were involved only in concentrate production in the U.S. (see Exhibit 2 for financial data on the leading soft drink competitors). Throughout most of the 1980s and 1990s, the price of concentrate sold to bottlers increased annually.

Bottlers

Bottlers purchased concentrate, added carbonated water and high fructose corn syrup, bottled or canned the soft drink, and delivered it to customer accounts. Coke and Pepsi bottlers offered “direct store door” delivery (DSD) which involved route delivery salespeople physically placing and managing the soft drink brand in the store. Smaller national brands, such as Shasta and Faygo, distributed through food storage warehouses. DSD included managing the shelf space by stacking the product, positioning the trademarked label, cleaning the packages and shelves, setting up point-of-purchase displays and end-of-aisle displays. The importance of the bottler’s relationship

With the retail trade was crucial to continual brand availability and maintenance. Cooperative merchandising agreements (CMAs) between retailers and bottlers were used to promote soft drink sales. Promotional activity and discount levels were agreed in the CMA with the retailer in exchange for a payment from the bottler.

The bottling process was capital-intensive and involved specialized, high-speed lines. Lines were interchangeable only for packages of similar size and construction. Bottling and canning lines cost from $4-$10 million for one line, depending on volume and package type. The minimum cost to build a small bottling plant, with warehouse and office space, was $20-$30 million. The cost of an efficient large plant, with about five lines and a 15 million case volume, was $30-$50 million. Roughly 80-85 plants were required for full national distribution within the United States. Packaging accounted for approximately 48% of bottlers’ cost of goods sold, concentrate for 35%, and nutritive sweeteners for 12%. Labor accounted for most of the remaining variable costs. Bottlers also invested capital in trucks and distribution networks. Bottlers’ gross profits often exceeded 40%, but operating margins were razor thin. See Exhibit 3 for the cost structures of a typical CP and bottler as of 1993.

Historically, CPs used franchised bottling networks. The typical bottler owned a manufacturing and sales operation in a small exclusive territory, with rights granted in perpetuity by the franchiser. In the case of Coca-Cola, the territorial rights did not extend to fountain accounts— Coke delivered to its fountain accounts directly, not through its bottlers. The rights granted to the bottlers were subject to termination by the CP only in the event of default by the bottler. The contracts did not contain provisions specifying the required performance of the bottlers or the CP. In the original Coca-Cola bottling contracts, the price of concentrate was fixed in perpetuity, subject to quarterly adjustments to reflect changes in the quoted price of sugar. There was no requirement for renegotiation due to changes in the cost of concentrate ingredients. Coke eventually amended the contract in 1978, which allowed it to raise the price of concentrate according to the CPI, and in the case of syrup, to adjust the price quarterly based upon changes in the average price per pound of sugar in the United States. In return, Coke was required to adjust pricing to reflect any cost savings realized as a result of a modification of ingredients, and allow bottlers to purchase unsweetened concentrate in order to buy sweetener on the open market. In late 1986, Coca-Cola proposed that its 1978 franchise agreement be replaced with the Master Bottler Contract, which provided additional pricing flexibility. By 1993, over 70% of Coke’s U.S. volume was covered by the Master Bottler Contract. Pepsi negotiated concentrate prices with its bottling association and normally based price increases on the CPI.

Coke and Pepsi’s franchise agreements allowed bottlers to handle the non-cola brands of other CPs. Franchise agreements also allowed bottlers to choose whether or not to market new beverages introduced by the CP. Some restrictions applied, however, as bottlers were not allowed to carry directly competitive brands. For example, a Coca-Cola bottler could not sell RC Cola, but it could distribute Seven-Up if it did not carry Sprite. Bottlers had the freedom to participate in or reject new package introductions, local advertising campaigns and promotions, and test marketing. The bottler had the final say in decisions concerning pricing, new packaging, selling, advertising and promotions in its territory. Bottlers, however, could only use packages authorized by the franchiser.

In 1971, the Federal Trade Commission initiated action against eight major CPs, charging that exclusive territories granted to franchised bottlers prevented intra-brand competition (two or more bottlers competing in the same area with the same beverage). The CPs argued that Inter-brand competition was sufficiently strong to warrant continuation of the existing territorial agreements. After nine years of litigation, Congress enacted the “Soft Drink Interbrand Competition Act” in 1980, preserving the right of CPs to grant exclusive territories.

Distributors

In the mid-1980s, U.S. distribution of soft drinks was through food stores (42%), fountain (20%), vending (12%), and other outlets (26%). By 1994, distribution of soft drinks shifted slightly: food stores (40%), fountain (17%), vending (8%), convenience stores and gas marts (14%), and other (21%). Mass merchandisers, warehouse clubs and drug stores made up about 12% of the other outlets. Profits for the bottlers varied by retail outlet (see Exhibit 4). Profits were driven by delivery method and frequency, drop size, advertising, and marketing. In 1993, the Pepsi-Cola brand and the Coca-Cola Classic brand each had a 16% share of all retail channel volume.

The main distribution channel for soft drinks was supermarkets. Soft drinks were among the five largest selling product lines sold by supermarkets, traditionally yielding a 15%-20% gross margin (about average for food products) and accounting for 4% of food store revenues in 1993. Soft drinks represented a large percentage of a supermarket’s business and were a big traffic draw. Bottlers fought for retail shelf space to ensure visibility and accessibility for its products and looked for new locations to increase impulse purchases, such as placing coolers at checkout counters. Supermarkets’ share of soft drink sales fell slightly due to consolidation in this sector, the rise of new retail formats, shelf space pressures due to increasing numbers of products, the introduction of supermarket private label soft drinks, and widespread discounting.

Discount retailers, warehouse clubs, and drug stores sold about 12% of soft drinks. Discount retailers and warehouse clubs often had their own private label soft drink, or they sold a private label such as President’s Choice. Private label soft drinks were usually delivered to a retailer’s warehouse, while branded soft drinks were delivered directly to the store. According to soft drink companies, retailers made a higher margin on DSD delivered soft drinks than on either private label, which was delivered to store warehouses or warehouse-delivered branded soft drinks (see Exhibit 5). Doug Ivester, Coca-Cola COO for North America, had this to say, “Coke delivers and stocks its soda, while Cott drops its pop at retailers’ warehouses. The trouble is, most retailers have never had a good understanding of what their costs are.”5 Soft drink companies made attempts to educate the trade about this difference in margins, although the issue was controversial. With the warehouse delivery method, the retailer was responsible for storage, transportation, merchandising and labor to get the product on the shelves. In effect, the retailer paid for additional labor, occupancy, inventory, and carrying costs. The extra costs reduced the private label net profit margin to the retailer versus the national brands.

Historically, Pepsi focused on sales through retail outlets, while Coke had always been dominant in fountain sales. Coca-Cola had a 59% share of the fountain market in 1993, while Pepsi had 27%. Competition for the fountain was intense, and was characterized by “significant everyday discounting to national and local customers.”6 National fountain accounts were essentially “paid to sample,” with soft drink companies breaking even at best. For local fountain accounts, soft drink companies earned operating profit margins before tax of around 2%. Soft drink companies used the fountain to increase the availability of its brands. For restaurants, a fountain was extremely profitable—soft drinks were one of their highest margin products. Coke and Pepsi invested in the development of fountain equipment, such as service dispensers, and provided their fountain customers with cups, point-of-sale material, advertising, and in-store promotions in order to increase trademark presence. After PepsiCo entered the restaurant business with the acquisitions of Pizza Hut, Taco Bell, and Kentucky Fried Chicken, Coca-Cola persuaded food chains such as Wendy’s and Burger King to carry Coke, by positioning these chains as competitors to PepsiCo’s three restaurants.

Coca-Cola and Pepsi were the largest suppliers of soft drinks to the vending channel. Bottlers purchased and installed vending machines, and CPs offered rebates to encourage them. The owners of the property on which vending equipment was located usually received a sales commission. Vending machine sales of soft drinks competed with the sale of competing beverages in vending machines, such as juice, tea, and lemonade.

Suppliers

CPs and bottlers purchased two significant inputs: packaging, which included $3.4 billion in cans (29% of total can consumption), $1.3 billion in plastic bottles, and $0.6 billion in glass; and sweeteners, which included $1.1 billion in sugar and high fructose corn syrup, and $1.0 billion in aspartame. In 1993, the majority of soft drinks were packaged in metal cans (55%), then plastic bottles (40%), and glass (5%). Cans were an attractive packaging material due to a variety of factors: vendibility, multi- packing capability, lightweight, un breakability, recyclability, and the ability to be heated or cooled quickly. Aluminum cans were the least expensive package per unit for soft drinks, due in part to the fact that Russia was dumping aluminum on the world market, cutting aluminum prices in half in 1993. Plastic bottles, introduced in 1978, boosted home consumption of soft drinks due to it’s larger 1- liter, 2-liter, and 3-liter sizes.

CPs’ strategy towards can manufacturers was typical of their supplier relationships. Coke and Pepsi negotiated on behalf of their bottling networks and were among the metal can industry’s largest customers. Since the can constitute about 40% of the total cost of a packaged beverage, bottlers and CPs often maintained relationships with more than one supplier. In the 1960s and 1970s, Coke and Pepsi backward integrated to make some of their cans, but mostly exited the business by 1990. In 1994, Coke and Pepsi sought to establish long-term relationships with their suppliers to secure supply. The significant metal producers cans included American National Can, Crown Cork & Seal, and Reynolds Metals. Metal cans were viewed as commodities, and there was chronic excess supply in the industry. Often two or three can manufacturers competed for a single contract, which resulted in low margins.

With the advent of diet soft drinks, Coke and Pepsi negotiated with artificial sweetener companies, most notably the Nutrasweet Company, and sold its concentrate to bottlers already sweetened. The second source of aspartame was the Holland Sweetener Company which was based in the Netherlands. Nutrasweet’s U.S. patent for aspartame expired in December 1992, which subsequently led to a weakening of Nutrasweet’s supplier power. As the cost of aspartame dropped, Coca-Cola amended its franchise bottler contract to pass along two-thirds of any savings or increase to its bottlers. In practice, Pepsi did the same thing to not disadvantage its bottlers in the marketplace compared to Coke’s, although it was not specified in its bottler contract. This was one of many examples in the cola wars where the competitors tracked and imitated each other.

History of the Cola Wars

The structure and character of the U.S. soft drink industry were molded by the 100-year competitive battle between Coke and Pepsi. Once a fragmented business with hundreds of local vendors, the soft drink industry in 1994 was highly concentrated. Coke and Pepsi had a combined 73% of the U.S. soft drink market. The top six companies, Coca-Cola, Pepsi, Dr. Pepper/Seven Up, Cadbury Schweppes, Royal Crown, and A&W Brands, had a combined 89% share of the market. The remaining 11% represented regional soft drink companies and private label brand manufacturers (see Exhibit 6).

The cola wars were fought on many fronts, such as advertising, packaging, and new products. Brand recognition was a competitive advantage that differentiated the soft drinks among

Consumers. Coke and Pepsi invested heavily in their trademark over time, with the marketing campaigns of Coke and Pepsi recognized as among the most innovative, sophisticated and aggressive of all significant advertisers (see Exhibit 7 for soft drink advertising expenditure). Coke and Pepsi sold only their flagship brand until Coke introduced Sprite in 1961 and Tab in 1963. The next move was Pepsi’s, with the introduction of Diet Pepsi and Mountain Dew in 1964. There was no looking back, and between the years 1961-1993, Coke introduced 21 new brands, and Pepsi introduced 24 new brands.

The emergence of the Duopoly

Coca-Cola and Pepsi-Cola were both invented in the late 1800s as a fountain drink. They each expanded through franchised bottlers—Coke with its uniquely contoured 6-ounce “skirt” bottle and Pepsi with a 12-ounce bottle; both sold for a nickel. Robert Woodruff, one of the most dominant figures in Coca-Cola’s history, worked with the company’s franchised bottlers to make Coke available wherever and whenever a consumer might want it. He pushed the bottlers to place the beverage “in arm’s reach of desire,” and argued that if Coke were not conveniently available when the consumer was thirsty, the sale would be lost forever. Woodruff developed Coke’s international business, principally through export. One of his most memorable decisions, made at the request of General Eisenhower at the beginning of World War II, was to see “that every man in uniform gets a bottle of Coca-Cola for 5 cents wherever he is and whatever it costs.” The company was exempted from wartime sugar rationing beginning in 1942 when the product was sold to the military or retailers serving soldiers. Coca-Cola bottling plants followed the movements of American troops, with 64 bottling plants established during the war— mainly at government expense. This led to Coke’s dominant market share in most European and Asian countries, a lead which the company still had in 1994.

In contrast to Coke’s success before WWII, Pepsi struggled, nearing the brink of bankruptcy several times in the 1920s and 1930s. By 1950, Coke’s share of the soft drink market was 47%, and Pepsi’s was 10%. Over the next 20 years, the Coca-Cola company never referred to its closest competitor by name. Coke’s management also referred to its famous brand name as “Mother Coke,” which was sacred and never extended to other products. “Merchandise 7X”, the formula for Coca-Cola syrup, was closely guarded. “Merchandise 7X has long been one of the best-kept secrets in the world. Coke was so protective of it that, when India demanded that they disclose the formula to its government, Coke closed its business in that hot and thirsty country of 850 million souls.”7

Beginning in the 1950s, Coca-Cola began using advertising that finally recognized the existence of competitors, as evidenced by slogans such as “American’s Preferred Taste” (1955), “Be Refreshed” (1958), and “No Wonder Coke Refreshes Best” (1960). In the 1960s, Coke along with Pepsi began to experiment with new cola and noncola flavors, packaging options, and advertising campaigns. They pursued market segmentation strategies, leading to new product introductions such as Pepsi’s Team and Mountain Dew and Coke’s Fanta, Sprite, and Tab. New packages included nonreturnable glass bottles and 12-ounce cans. Coke and Pepsi both looked outside the soft drink industry for growth in the 1960s: Coke purchased Minute Maid, Duncan Foods, and Belmont Springs Water; Pepsi merged with Frito-Lay to become PepsiCo, claiming synergies based on shared customer targets, store-door delivery systems, and marketing orientations (see Appendix A on the corporate histories of Coke and Pepsi).

Through most of this period, Coke did not aggressively attack Pepsi head-on. Coke maintained a highly fragmented bottler network, with 800 bottles, that focused on U.S. cities of

50,000 or less. In fact, much of Coke’s efforts during this period was on overseas markets, where it generated almost two-thirds of its volume by the mid-1970s. In the meantime, Pepsi aggressively fought for a share in the United States, doubling its share between 1950 and 1970. Pepsi’s franchise bottling network was generally more extensive, more flexible, and often offered lower prices to national chain stores. Slowly but surely, Pepsi crept up on Coke, mainly by focusing its attention on take-home sales through supermarkets. In fact, Pepsi’s growth mostly tracked the growth of supermarkets and convenience stores. There were about 10,000 supermarkets in the United States in 1945, 15,000 in 1955, and 32,000 at the height of their growth in 1962. There were about 24,000 convenience stores in 1970.

Pepsi’s 1963 “Pepsi Generation” campaign communicated to the young, emphasized consumer lifestyle and gave Pepsi an image that could not be confused with Coke’s nostalgic, small-town America image. Pepsi’s ad agency created a great and visual commercial using sports cars, motorcycles, helicopters, non-actors, a catchy jingle, and the phrase, “Come Alive— You’re in the Pepsi Generation.” The campaign was so successful that Pepsi narrowed Coke’s lead to a 2-to-1 margin. But the most aggressive move by Pepsi was about to come.

The Pepsi Challenge

The “Pepsi Challenge” in 1974 was considered Coke and Pepsi’s first head-on collision in public. When the Pepsi Challenge was invented in Dallas, Texas, Coke was the dominant brand in the city. Pepsi ran a distant third behind Dr. Pepper, which had its headquarters in Dallas. In blind taste tests, run by Pepsi’s small local bottler, the company demonstrated that consumers preferred Pepsi to Coke. After Pepsi sales shot up, the company started to roll out the campaign nationwide. Coke countered with rebates, rival claims, price cuts, and a series of advertisements questioning the tests’ validity. Coke’s price discounting response was mostly in markets where the Coke bottler was company owned, and the Pepsi bottler was an independent franchisee. But the Pepsi Challenge fueled the erosion of Coke’s market share; in 1979 Pepsi passed Coke in food store sales for the first time with a 1.4 share point lead. Advertising expenditure increased significantly from 1975-1980, when Coca-Cola’s advertising doubled from $34 million to over $70 million, with Pepsi’s advertising rising from $25 million to $67 million.

Coke’s attention was diverted at this crucial time towards the negotiation of the new bottling franchise contract in 1978. In May of that year, Don Keough took what derisive bottlers called his “dog and pony show” to six meetings around the country to persuade hesitant bottlers to sign.8 Approval came only after the company agreed to supply Coca-Cola concentrate to bottlers without sweetener. This brought Coke’s policies in line with Pepsi, which sold its concentrate unsweetened to its bottlers. Pepsi countered with a price increase to its bottlers of 15%, announced shortly after Coke’s increase.

The FTC inquiry over exclusive franchise territories occurred during this period (1971-1980), and Coca-Cola officials admitted that they took their eye off the ball while Pepsi kept its cola business sharply in focus. Don Keough said of this period, “Our system was immobilized. Looking back, I should have hired a room full of lawyers and told them to deal with it, and we could have gotten on with the business.”9 Coke was so rattled that Brian Dyson, president of Coca-Cola, broke precedent and uttered the name Pepsi in front of most of Coke’s bottlers at a 1979 bottlers conference, by saying,

“Coca-Cola’s corporate share has grown a mere three-tenths of one percent in ten years. In the same period, Pepsi’s corporate share has grown from 21.4% to 24.2%”10

Cola Wars Heat Up

In 1980 Coca-Cola experienced a change in management when Roberto Goizueta became CEO and Don Keough president. Goizueta described the corporate culture when he took over: “Unprofessional would be an understatement. We were there to carry the bottlers’ suitcases. We used to be either cheerleaders or critics of bottlers. Now we are players.”11 Under Goizueta, Coke began buying up its bottlers in earnest. Coke was first to drop sugar and adopt the lower-priced high fructose corn syrup, a move which Pepsi eventually imitated in 1983. Pepsi’s president Roger Enrico had this to say, “Coke’s fructose decision was probably the first that Roberto Goizueta and Don Keough—the management team that was about to take charge of the Coca-Cola company—made using their ready-fire-aim philosophy. Given that new philosophy, they probably didn’t do much testing. More likely they just looked at the cost savings, bet that it wouldn’t hurt sales, and blasted away.”12 Goizueta sold off most non-soft drink businesses that he inherited, including wine, coffee, tea and industrial water treatment. Coca-Cola intensified its marketing effort, with advertising expenditure rising from $74 million in 1981 to $181 million in 1984. Pepsi also stepped up advertising from $66 million to $125 million over the same period. Coca-Cola continued to pursue its expansion overseas with growing investments.

For the first time, the Coca-Cola company used the “Coke” brand as a line extension when it introduced diet Coke in 1982. Opposed by company lawyers as a risk to the copyright, this was a significant departure in strategy. But, diet Coke was a phenomenal success—probably the most successful consumer product launch of the Eighties. By the end of 1983, it was the nation’s most popular diet cola, and in 1984, it became the third-largest seller among all domestic soft drinks. In addition to diet Coke, new soft drink brands proliferated, with Coke introducing 11 new products including Cherry Coke, Caffeine Free Coke, and Minute-Maid Orange. Pepsi introduced 13 products including Caffeine Free Pepsi-Cola, Lemon Lime Slice, and Cherry Pepsi. The battle for shelf area in supermarkets and other food stores became fierce. One of Pepsi’s most visible responses to Coke was an advertising blitz, featuring rock star Michael Jackson.

As new brands exploded, price discounting also emerged which eroded margins for all carbonated soft drink manufacturers. Industrywide, there was a sharp increase in the level of discounting in the struggle for market share. Consumers were exposed continuously to cents-off promotions and a host of other discounts. Consumers who formerly bought only one soft drink brand bought whatever was on sale, switching brands each time they made a purchase.

The most dramatic shot in the cola wars came in 1985 when Coke changed the formula of Coca-Cola. Explaining this break from tradition, Goizueta saw the “value of the Coca-Cola trademark going downhill” as the “product and the brand had a decreasing share in a shrinking segment of the market.”13 Coca-Cola was not prepared for the intensely adverse reaction from its core group of loyal customers, most of whom consumed vast amounts of Coca-Cola each day. As a result of this reaction, the company brought back the original formula three months later under the name Coca-Cola Classic, while keeping the new formula as the flagship brand under the name New Coke. With consumers still unhappy, Coke announced six months later that Coca-Cola Classic (the

Original formula) would be considered its flagship brand. Reflecting on the introduction of new Coke, some insiders said that the reformulation would have been dropped if Coke had not been intent on finding new ways to attack Pepsi. Similarly, Pepsi’s early introduction of a 3-liter bottle in 1984 was continued despite a lukewarm reception by consumers. A Pepsi marketer explained, “Even if it wasn’t working, we had to stay out front on this . . . we want to jump off the cliff before Coke.”14

In the ongoing battle for market share, Coke and Pepsi tried to buy the most prominent niche players in the United States. In January 1986, Pepsi announced its intention to acquire Seven-Up from Philip Morris. In response, Coca-Cola countered with an announcement one month later that it planned to acquire Dr. Pepper. In June of that year, the Federal Commerce Commission voted to oppose both acquisitions. Pepsi did, however, acquire Seven-Up’s international operations.

In the 1980s, the smaller CPs were shuffled from one owner to another. In five years, Dr. Pepper would be sold (all and in part) a couple of times, Canada Dry twice, Sunkist once, Shasta once, and A&W Brands once. Food companies made some of the deals, but several were leveraged buyouts by investment firms. At the same time, many formerly independent bottlers were being absorbed and merged (see Appendix B).

Reorganizing the Industry

Buying-Up Bottlers

Beginning in the mid-1980s, Coke and Pepsi began a process of altering the structure of the franchise system. At the start of the 1980s, Pepsi and Coke each owned about 20-30% of their bottles. Pepsi company-owned bottling operations in the United States made up 55.7% of Pepsi’s volume in 1993, with Pepsi’s equity partner volume at 70.8%; Coca-Cola had equity in four bottlers representing 70.1% of volume. Pepsi’s top 10 bottlers had 81% of volume, and Coke’s had 86%. Analysts gave several reasons for purchasing bottles. At the outset, the cola wars weakened many independent bottlers, leading franchises to seek buyers. Some of the bottles were small, producing under 10 million cases a year, and did not have the capability or the time frame to handle corporate goals in a particular market. Others were bought because they were located near a company-owned bottler, or they were underinvesting in plant and equipment.

In 1986 Pepsi-Cola decided to acquire its bottling system proactively. Over the next few years, Pepsi acquired MEI Bottling for $591 million, Grand Metropolitan’s bottling operations for $705 million, and General Cinema’s domestic bottling operations for $1.8 billion. Because PepsiCo was an asset-intensive company—the concentrate business of Pepsi-Cola was the exception—the company believed it had strong competencies in managing the capital-intensive bottling business. Coca-Cola, on the other hand, wanted a clean balance sheet. In 1985, 11% of Coca- Cola’s volume was produced by company-owned bottlers. One year later, Coca-Cola bought two substantial bottling concerns which together with bottling plants it already owned, brought its share of Coke production to one-third. The acquisitions culminated in the creation and sale of 51% of Coca-Cola Enterprises (CCE) to the public, with Coke retaining a 49% share. By 1992, CCE was the largest Coca-Cola bottler with sales of $5 billion. CCE was moving towards “mega-facilities” or 50-million case production facilities with high levels of automation and with a large warehouse and delivery capabilities.

Pepsi, like Coke, saw several advantages in controlling bottlers. Pepsi went from 435 bottles down to 120 bottles, with Pepsi owning 56% of them outright, and equity positions in most of the others. The trend towards buying bottlers was set to continue in the 1990s, though the franchise system was predicted to be around for the foreseeable future. Pepsi had no corporate owners and tended to keep its bottling network more local, and its bottling plants smaller than Coke’s. The most efficient Pepsi plant size produced a 10-15 million case volume.

The consolidation of bottlers meant that the smaller concentrate producers, except RC Cola, had to sell their products through the Pepsi or Coke bottling system. Not surprisingly, the Federal Trade Commission kept the soft drink industry high on its list of priority industries. Pepsi and Coke nonetheless continued to look at the industry as a total system rather than individual markets, and despite greater vertical integration, they continued to run their bottlers as independent businesses. Both companies raised concentrate prices through the early 1990s and required bottlers to share marketing expenditures.

Changing Distribution Channels and Private Label

With the rapid growth of discount retailers such as Wal-Mart and K Mart and warehouse clubs such as Sam’s Clubs and PriceCostco, this became an increasingly important outlet for soft drink distribution. With sales estimated to reach $87 billion in 1994, Wal-Mart was predicted to use the supercenter format (a combination supermarket and discount store) as its primary growth vehicle for the 1990s. Wal-Mart stocked both Coke and Pepsi in its discount stores, warehouse clubs and supercenters. Although Coke and Pepsi sold their products to Wal-Mart and supermarkets at the same price, Wal-Mart had lower operating costs and earned higher margins. As a result, supermarkets were putting pressure on soft drink companies to offer them lower prices.

Wal-Mart, along with other retailers, sold its private label cola. With soft drink growth slowing, this presented a challenge to national brand growth. Although Americans still drank more soft drinks than any other beverage, sales volume registered only a 1.5% increase in 1992, to just under 8.2 billion cases (a case was equivalent to 24 eight-ounce containers, or 192 ounces). This slow growth was in contrast to the 5%-7% annual growth in the 1980s. According to industry analysts, store brands often sold for up to 35% less than national brands. The primary supplier to private label retailers in the United States was the Cott Corporation, which bought its concentrate from RC Cola. Cott bottled or canned the cola, sold it under private labels such as President’s Choice, and had arrangements with more than 40 retail chain stores, including American Stores, Safeway, A&P, and Wal-Mart. Cott produced four different formulas for cola and could tailor a product to meet individual customer demands.

Private label colas were not a new phenomenon. Their share of food store sales reached a peak of 12.8% in 1971, slowly declined each year in the 1970s, and hovered around 7% throughout the 1980s. In 1993, the private label had 9% of volume. In the 1990s, supermarkets were developing private label colas as they questioned the profitability of national brands, and they used private label products to enhance the store identity and build patronage. Coke executives met with security analysts in May 1993 to address the issue of private label, “We, along with our major competitor, have addressed consumer needs with sugar-free, caffeine-free, and other variations. We understand how to deal with this [private label] phenomenon. We have been dealing with it effectively for years.”15 Coke executives noted that private label competed only on price, and consumers paid the same price for a Coke in 1993 that they paid ten years earlier.

New Age Beverages

Another challenge for carbonated soft drink companies were “new age” beverages such as bottled waters and tea-based drinks. When measured in gallons, sales of new age beverages rose by 17% in 1992, compared to 1.5% for bottled water and 1.5% for all soft drinks. While this gain came from a much smaller base (250 million gallons were sold in 1992, compared with 12 billion gallons of all soft drinks), such growth interested Coke and Pepsi. In the 1990s, Coke introduced PowerAde, Nordic Mist, and Tab Clear; Pepsi introduced Crystal Pepsi, Diet Crystal Pepsi, All Sport, Tropical Chill, and Strawberry Burst. In tea drinks, Coke joined up with Nestea and Pepsi with Lipton, with Pepsi planning to invest $50 million in upgrading and expanding its hot-fill capacity for its ready to drink iced tea brands. In 1993, the new age beverage segment was worth $900 million. Leading the charge was Canadian’s array of 11-ounce blue-tinted bottles of clear, naturally flavored sodas, followed by Snapple’s variety of bottled drinks. Snapple’s net revenue increased from $13 million in 1988 to $232 million in 1992. The company had several flavors, and a 33% share of the ready-to-drink tea market, the most significant share in this category.

In 1993, flavored soda sales grew more than twice as fast as cola sales in supermarkets. Dr. Pepper and Mountain Dew sales, for example, were up 10% each at grocery stores, for the 40 weeks ending October 3, 1993. Pepsi promoted its nine fruit-flavored Slice brands, and Coke was pushing its Dr. Pepper-competitor Mr. Pibb as well as an expanded line of Minute Maid flavors. In contrast to flavored sodas, the growth of diet soft drinks slowed dramatically from the double-digit expansion in the late 1980s. In 1992, the diet segment did not increase for the first time in its history. Analysts predicted little or no growth in 1993 due to new age beverages, private label brands, and declining brand loyalty. In part to address these trends, Pepsi pronounced itself a “total beverage company,” while Coca-Cola appeared to be moving in the same direction. The philosophy behind the strategy, according to Pepsi’s VP for new business, was that whenever an American sipped a beverage, that beverage should be a Pepsi-Cola product. “If Americans want to drink tap water, we want it to be Pepsi tap water.”16 Both companies predicted increased market share from beverages outside of carbonated soft drinks. As part of this repositioning, Coca-Cola embarked on a strategy to change its image by dropping McCann-Erickson, its principal ad agency since 1955, and hiring Creative Artists Agency (CAA), a Hollywood talent firm. Coke wanted to revitalize its advertising and overcome the perception that the hip soft drink for the youth market was Pepsi.17

Internationalizing the Cola Wars

In the 1990s, some of the most intense battles of the cola wars were being waged in international markets. The opportunities for international soft drink unit case growth and profits were enormous because per capita consumption levels worldwide were a fraction of the U.S. market. For example, the average American drank 296 eight-ounce Coca-Cola soft drinks in 1993; the average person in China drank one. If Coke boosted Chinese purchases to the annual per-person consumption of Australia, which was 217, “it would be the equivalent of another Coca-Cola company the size it is today. It would be 10 billion cases a year,” Goizueta said.18 Industry analysts believed that the international market would grow by 7%-10% per year.19 Some of the more exciting areas included Eastern Europe, China, and India, where Coke and Pepsi’s business had been limited, or prohibited, in the past. Coca-Cola had a global market share of 45% in 1993, compared to Pepsi’s

14%. Coke’s profitability was particularly strong in Germany, where it had a 50% share of the market. Coke was also the market leader in Western Europe, Japan, and Mexico. Pepsi’s greatest strength was in the Middle East, Eastern Europe, and Russia (see Exhibit 8).

Coke and Pepsi took different long-term approaches to the international soft drink market. Pepsi had company-owned bottlers in many international territories, while Coca-Cola made equity investments in franchisees. Unlike the U.S. market, international bottling contracts usually did not contain restrictions on concentrate pricing, which gave CPs much more flexibility to raise the price of concentrate. Overseas bottling contracts were not perpetual and were usually for a 3-10 year duration. Operating margins were as much as ten percentage points higher in many international markets compared to the U.S. CPs made concentrate pricing decisions on a country-by-country basis taking into account local conditions. Retail pricing was established by the local bottlers with input from the franchiser and was based on channel development, growth in disposable income, and availability of alternative beverages. There were barriers to growth in many countries including price controls, lack of remittable profits, foreign exchange controls, political instability, restrictions on advertising, raw material sources, and environmental issues.

In 1992, Coke earned 80% of its profits outside of the United States, while Pepsi-Cola earned 15%-20% of its profits outside the U.S. Coke executives predicted that international operations would contribute 85% of operating income by the end of the decade. Beginning in the 1980s, coke refranchising and restructured its international bottlers, particularly those who were having difficulty managing their territories, by providing capital and management expertise to promote profitable volume growth. Coke employed a strategy of “anchor bottlers”—large, committed, and experienced bottling outfits like Norway’s Ringnes and Australia’s Amatil—who were pioneering new markets like China, Eastern Europe, and the former Soviet Union. Similar to its U.S. approach, Coke tended to own stakes of less than 50% in its overseas bottlers. Coke also liked to invest enough in influencing local management. Coke built brand presence in markets where soft drink consumption was low but where the long-term profit potential was large, such as Indonesia with a population of 180 million, a median age of 18, and a per-person consumption of only four Coca-Cola soft drinks a year. As one Coke executive noted, “They sit squarely on the equator and everybody’s young. It’s a soft drink heaven.”20 From 1981-1993, Coke invested over $3 billion internationally. Goizueta said, “We have just begun reaching out to the 95% of the world’s population that lives outside the United States. Today our top 16 markets account for 80% of our volume, and those markets only cover 20% of the world’s population.21 Coke’s equity or joint venture interest was in more than 38% of its worldwide volume in 1993.

Pepsi was slower off the mark than Coke in focusing its international effort. In the mid-1970s, Pepsi was concerned with domestic operations, and after experiencing problems in Mexico and the Philippines in the early 1980s, began selling off its international bottling investments. The money went towards buying back domestic bottlers and increasing efficiency and profitability. But, PepsiCo Foods International (PFI) continued to operate in seven countries, and the company found it could perform well overseas. By the late 1980s, Pepsi-Cola began to rethink its international effort and decided that if it wanted to grow 17%-18% annually, it would have to invest outside the United States. Many of its remaining foreign bottling operations were run inefficiently: they were under- marketing, the product quality was inconsistent, and there was no uniformity in graphics standards. Pepsi-Cola International’s president, Chris Sinclair, had this to say,

We were horrible operators internationally. I can’t be blunter than that. It was not uncommon to find 20%-30% levels of distribution in specific markets. We had bottling operations that didn’t know their customers and didn’t think about things like, “How do I optimize selling and delivery?” We had cost structures

That was woefully uncompetitive. We had to attack not only the cost issues out there in the system, but, more importantly, the customer service issues.22

Pepsi utilized a niche strategy which targeted geographic areas where per capitas were relatively established, and the markets presented high volume and profit opportunities. These were often “Coke fortresses,” and Pepsi put its guerilla tactics to work. One example of such an assault was in Monterrey, Mexico, where 90% of the market belonged to Coke’s local bottler. In the Spring of 1992, with the precision of an infantry battalion, Pepsi tripled its market share to 24% in four months, using a well-trained team, 250 new trucks, and a new state-of-the-art bottling plant. Another Coke fortress was Japan, where a “Pepsi Challenge” was launched before a judge issued an injunction against Pepsi to stop using its competitor’s name in its advertising. Coke responded to these attacks by lowering its prices in international markets to build volume.

Pepsi established local bottling partners either through joint ventures, equity investments or direct control. Unlike Coke who used anchor bottlers to enter a new market quickly, Pepsi was faced with finding bottling partners who possessed adequate business skills. Its bottlers worked closely with the local retail trade to build brand presence and availability. Pepsi restructured or refranchised about half of its international bottling network since 1990, investing almost $2 billion. Including company-owned bottling operations, Pepsi maintained equity control in over 20% of its bottling system on a volume basis, and about 50% on a revenue basis.

Analysts believed that the international game would ultimately be played in Latin America, India, China, and Eastern Europe. With several of these markets expanding rapidly, the question for all soft drink companies in the late 1990s was: will the battle for the global soft drink market evolve into another dominant duopoly like the United States, or will a different pattern emerge, with different players, different vertical structures, and different margins?

Corporate History of Coke and Pepsi Major Acquisitions and Divestitures

Coca-Cola

Coca-Cola was incorporated in 1919. Its primary business was the production of carbonated soft drink concentrate and syrups. Over the years, Coca-Cola bought and sold many different businesses (the following list contains the acquisitions and sales of franchised bottlers which were over $200 million).

1981: Sold Aqua-Chem, maker of water conversion systems, to Lyonnaise American Holdings.

1982: Acquired Columbia Pictures for a purchase price of $333 million in cash and stock valued at $692 million. Acquired Ronco Foods Company, a manufacturer, and distributor of pasta products. In June, purchased Associated Coca-Cola Bottling Co. for
$419 million; by the end of the year, 70% of Associated’s operating assets had been sold.

1983: Sold its wine business for $230 million.

1984: Sold Ronco Foods Company.

1985: Sold Presto Products and Winkler Flexible Products for $112 million. Bought certain assets and properties of Embassy Communications and Tandem Productions for $267 million, comprised of 7.1 million shares of the company’s common stock and the payment of existing debt. Tandem was purchased for $178 million in cash. Embassy and Tandem were producers and distributors of television programs. In 1986, sold Embassy Home Entertainment to Nelson Entertainment for $85 million. Acquired
Nutri-Foods International, a manufacturer of juice-based frozen desserts, for $30 million.

1986: Acquired January Enterprises (now Merv Griffin Enterprises) for $200 million.
Transferred the operating assets of company-owned bottling companies in the U.S. to Coca-Cola Enterprises, a 49% owned subsidiary. Acquired the Coca-Cola Bottling Company of Southern Florida for $325 million, and Coca-Cola bottling companies affiliated with Mr. Crawford Rainwater for $211 million.

1987: Cadbury Schweppes and Coke formed a joint venture company known as Coca-Cola and Schweppes Beverage Ltd., which handled bottling, canning and distributing of the companies’ products in Great Britain.

1988: Acquired the citrus food service assets of H.P. Hood for $45 million. Sold Coca-Cola Bottling Cos. of Memphis, Miami, and Maryland, and a portion of the Delaware operation, to Coca-Cola Enterprises for $500 million.

1989: Acquired S.P.B.G., a subsidiary of Pernod Ricard. Sold Coca-Cola Foods’ coffee business to Maryland Club Foods. Acquired the outstanding stock of Frank Lyon Co, the sole shareholder of Coca-Cola Bottling Company of Arkansas, for $232 million.
Acquired all of the Coca-Cola bottling operations of Pernod Ricard for an aggregate purchase price of $285 million, and liabilities assumed were $145 million. Acquired a 59.5% share in Coca-Cola Amatil Ltd. for an aggregate purchase price of $491 million. Sold Belmont Springs Water Co. to Suntory Water Group. Sold Columbia Pictures Entertainment to Sony for $1.55 billion.

1990: Sold Coca-Cola Bottling Company of Arkansas to CCE for $250 million.

1991: Coke and Nestle formed the Coca-Cola Nestle Refreshments Company, which manufactured ready to drink coffee, tea, and chocolate beverages under the Nescafe, Nestea, and Nestle brand names.

PepsiCo

The Pepsi-Cola company was mainly a beverage company until 1965 when Pepsi acquired Frito-Lay and became PepsiCo. PepsiCo later purchased Pizza Hut, Taco Bell, and Kentucky Fried Chicken to become the world’s largest restaurant group.

1968: Acquired North American Van Lines for 638,818 common shares, and Chandler Leasing Corp. for 482,498 shares.

1972: Acquired Wilson Sporting Goods Company. In 1985, sold Wilson for $134 million in cash and 10% Wilson preferred stock. Acquired 82% of Rheingold Corp, and in 1973, acquired remaining shares. In 1974, sold Rheingold’s brewing operations and changed Rheingold Corp’s name to United Beverages. Sold Lease Plan to Gelco-IVM Leasing Co. of Minneapolis for $6.7 million.

1976: Acquired Lee Way Motor Freight. In 1984, sold Lee Way to Commercial Lovelace Motor Freight.

1977: Acquired Pizza Hut through the exchange of 1.55 Pepsi shares for each Pizza Hut share.

1978: Acquired Taco Bell through the exchange of shares valued at $148 million.

1985: Acquired the bottling subsidiary of Allegheny Beverage Corp. for $160 million in cash.
Sold North American Van Lines for $376 million.

1986: Acquired MEI Bottling Corp for $591 million in cash. Acquired Seven-Up International for $246 in cash. Acquired Kentucky Fried Chicken for $841 million in cash.

1989: Acquired the domestic franchised bottling operations of General Cinema for $1.77 billion. Acquired the capital stock of Smiths Crisps Ltd. and Walker Crisps Holding Ltd., two snack food companies in the U.K., for $1.34 billion.

1990: PFI, through its Mexican snack food subsidiary, Sabritas S.A., acquired over 70% of the stock of Empresas Gamesa for $300 million.

1991: PFI purchased the remaining 50% interest in the Hostess Frito-Lay Company from Kraft General Foods Canada Inc. Terms were not disclosed.

1992: PFI acquired Evercrisp Snack Productos de Chile S.A. for $12.6 million, one of the leading snack food producers in Chile.

Appendix B

Other Concentrate Producers

Dr Pepper/Seven-Up Companies

Seven-Up, a lemon-lime drink, was introduced in 1929. The majority of its bottlers also bottled Coke, Pepsi, or RC Cola. By the 1950s, Seven-Up achieved national distribution through its franchise network and owned a small number of bottling operations. Dr. Pepper, formulated in 1885 in Texas, had a unique taste based on a combination of juices and called for less sugar than the leading brands. It started out as a small, regional producer in the southwest. In 1962, a court ruled that Dr. Pepper was not a cola. Therefore Coke and Pepsi bottlers could carry it. Dr. Pepper expanded its geographic base by granting franchises to Coke and Pepsi bottlers across the country. Eighty percent of Dr. Pepper was distributed through the Coke or Pepsi bottling systems in 1993.

Philip Morris acquired Seven-Up in 1978 for a significant premium, and then racked up massive losses in the early 1980s. By 1985, Philip Morris was looking for a buyer. The FTC blocked Pepsi’s purchase of Seven-Up, although Pepsi purchased Seven-Up’s Canadian and international operations for $246 million. Philip Morris sold Seven-Up’s domestic operations to an investment firm led by Hicks & Haas for $240 million. By October 1986, Hicks & Haas completed leveraged buyouts of A&W Brands, a specialty concentrate producer, for $75 million, and Dr. Pepper’s concentrate business for $416 million. At the end of 1986, Hicks & Haas had a 14% share of the U.S. soft drink market. Dr. Pepper/Seven-Up Companies was a holding company formed in 1988 to acquire the Dr. Pepper Company and the Seven-Up Company. It was the largest noncola soft drink franchiser in the U.S. in 1993 with a market share of 11%. Coke and Pepsi bottlers distributed more than 70% of its volume. Cadbury Schweppes held 26% of the company’s stock in 1993.

Royal Crown Cola (RC Cola)

Royal Crown introduced its first cola in 1935 and was the first to introduce regular and decaffeinated diet cola. Its franchise bottlers, mostly located in the midwest, also sold Seven-Up, Dr. Pepper, and other small brands. In 1984, Royal Crown was acquired by financier Victor Posner’s DWG Corporation. RC Cola was a subsidiary of Royal Crown Corporation, which was a subsidiary of CFC Holdings Corporation, a subsidiary of DWG Corporation. In 1993, Posner sold a controlling interest in DWG to Nelson Peltz and Peter May, who changed the name from DWG to Triarc. RC Cola was the third largest national brand cola in 1993, with sales outside of the U.S. accounting for 7.5% of sales. RC Cola was the exclusive supplier of cola concentrate to Cott, a private label soft drink supplier to major retailers.

Other Brands

In 1984, Canada Dry was sold to R.J. Reynolds, which also purchased Sunkist from General Cinema, combining it with earlier purchases of Del Monte’s Hawaiian Punch and Cott Beverages. By 1985, R.J. Reynolds controlled 4.6% of the U.S. soft drink industry. In June 1986, R.J. Reynolds sold Canada Dry and Sunkist to Cadbury Schweppes. In 1989, Cadbury-Schweppes acquired Crush International from Proctor & Gamble, which included the Hires brand. In the same year, the company also relocated its beverage headquarters from London, England, to Stamford, Connecticut. In 1990, Cadbury Schweppes refranchised its Canada Dry, Hires and Crush products, with the goal of making the brands national.